For more than five years now, the U.S. stock market has mostly soared upward as the global financial system emerged from the wreckage of the housing bust, the banking crisis and the ensuing market meltdown. Yet several looming threats could put the brakes on those gains, and investors appear increasingly nervous about whether stocks will keep providing the returns they've grown accustomed to. Let's look at what the rest of 2014 is likely to bring.
The Halloween Scare
October routinely scares many investors, and despite the irrationality of many seasonal investing strategies, it's easy to understand why with a simple look at history. The Crash of 1929 that many blame for setting the stage for the Great Depression occurred in October, as did its 1987 successor, which featured the largest single-day percentage drop in the Dow Jones Industrials (^DJI). Over the years, other minor market disruptions happened during October. And while the last financial crisis started gaining momentum in the summer, October 2008 produced two of the five worst days in history for the Dow in terms of point declines.
%VIRTUAL-WSSCourseInline-975%In 2014, investors have a lot more to be frightened of than Halloween decorations. Geopolitical tensions in Russia, Ukraine, the Middle East and most recently Hong Kong have caused great economic uncertainty. Europe's economy remains unable to produce more than the tiniest amount of growth, and even with the U.S. looking strong by comparison, economists fear that as the Federal Reserve removes some of the stimulus measures it introduced to prop the economy up during the downturn, we might have trouble adjusting to the new conditions. Meanwhile, a strong U.S. dollar will put pressure on American companies doing business overseas, as the money they earn abroad will translate into fewer dollars of sales and profit.
Many parts of the stock market have already seen the impact of this nervousness. Even as the Dow hit new record highs just a couple of weeks ago, broader-based indexes like the small-cap Russell 2000 (^RUT) have fallen as much as 10 percent from the highs hit earlier this year, and some stocks have seen even larger declines. As those headwinds have emerged, investor sentiment has grown guarded. The latest report from the American Association of Individual Investors shows that almost 42 percent of investors remain bullish on the prospects for the market over the next six months, but the number of those who are bearish rose 5 percentage points in a single week to 28 percent.
Many of these concerns aren't new. The stock market has been resilient in the face of challenges for years now, and pessimistic analysts have been dead wrong in their timing calls.
You Can't Predict the Future, but You Can Prepare for It
Unfortunately, expecting to predict whether stocks will soar or crash before 2014 ends is an exercise in futility. What is certain, though, is that the market will continue to gyrate, and despite a longer-than-normal period during which stocks have avoided major declines, corrections and bear markets will happen sooner or later.
Still, just because you can't be sure which way the market will move doesn't mean you can't prepare for whatever may happen. Whenever you start feeling nervous about your investments, it's smart to take a three-step approach:
Assess the risk level of your investments. Often after a long bull market, your stocks will be worth more, and you'll therefore have more to lose if they fall. Consider rebalancing your investments to ensure that you're comfortable with your risk level.
Raise needed cash while stocks are still high. If you anticipate needing money for expenses in the next year or two, then making sure you have that money available now will prevent you from having to think about selling stocks in the future, when they might not be as high as they are now.
Start making a stock shopping list. If you still have a long time horizon with your investments, a stock market crash can actually be a good thing by letting you buy shares of great stocks at cheap prices. But rather than trying to make decisions in the heat of the moment, look now for companies you'd want to own if their shares were less expensive. That way, you'll be ready to pull the trigger when a downturn happens.
With threats facing the stock market, it's entirely possible that stocks won't finish 2014 with the happy ending that so many investors want. But by looking at your investments now, you can make sure you're in a position to celebrate the new year in 2015 even if stocks don't close out the year on a high note.
You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google+. To read about our favorite high-yielding dividend stocks for any investor, check out our free report.